How to Make a Cap Table:
Venture Capital 101 for Investors
Venture capital firms and investment companies use a capitalization table, also called a cap table spreadsheet, to identify all the owners of a company. The capitalization table shows what percentage of ownership each one has, how the ownership vests over time, and what other warrants and/or stock options exist that may change the ownership interests in the future.
Cap Tables Create Company Valuation
When an angel investment group wants to invest in startups by providing private equity funds, an important part of the decision is the cap table startups have, because this information impacts the return on investment in the future for the private equity firms. Venture capital financing makes use of a capitalization table to show the composition of the company’s ownership, what values the securities had that the company issued, and the potential for dilution of ownership.
Dilution is a process where an organization authorizes and issue more stock, thereby reducing the actual percentage ownership held by the existing owners in a company.
Here is a simple example that illustrates the impact of dilution:
A company has the authorization to issue 2 million common shares of stock. It issued one million shares. An existing owner has 100,000 shares. This is equivalent to 10% of the company. When the company issues the second million shares, the owner with 100,000 shares will own only 5% of the company (100,000 shares of a total 2 million). Without any protection from dilution, this investor has her or his ownership position cut in half.
The percentage ownership in a company is only half of the valuation equation. The other half of this calculation is the value of the shares. In the example above, if a person owns 10% of the company and the shares are valued at $1 per share, then 100,000 shares have the value of $100,000.
If a new investor comes in and agrees to pay $2 per share, the company valuation goes up. In this case, this means even though the percentage ownership in the company went down because of dilution, the value of the shares went up, so the 100,000 shares representing only 5% of the company are now worth $200,000.
Top venture capital firms know when the share price increases in value this offsets the impact of dilution. The reverse is also true, if the share price decreases in value the impact of dilution is greater.
How to Create a Capitalization Table
The first step in creating a capitalization table is to gather information, such as:
- Identify all the founders and their equity ownership position in the company
- Determine if there are employee incentives, such as stock options, and review the documents regarding how these programs function
- Note any provisions for special compensation to advisors, partners, or key employees
- Identify all the stockholders
- Identify all the stock option holders
- List all the owners, the classes of stock that they own, the price paid for the stock, and how much stock each person or entity owns in the company
After all the data is collected, a calculation adds up the total amount of shares. Another calculation is the total amount of money paid for the shares. Ownership calculations for each owner consider a fully diluted basis. This means including all possible options, whether or not issued and whether or not vested. The assumption for making the total calculations in this way is that all options will eventually be issued and all will eventually be vested (owned by the person or entity that has a right to them).
Creating and using a capitalization table is how to see the “big picture” of the ownership of a company. An example created by Fred Wilson of AVC shows how the cap table looks. Venture Hacks also gives a nice video walk-through of how to make a capitalization table.
When a capitalization table shows the increase in company value over time, this information is encouraging for successful companies.
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